Feb 2008 - Demise of US $

The Demise of the US$

It should be emphasised that this column is based on observations, and hence may violate some standard economic theories. Having said that, the US$ looks like yesterday’s currency, now is the day of Euro as shown in Figure 1. This results in a significant impact on any metal price forecasting in that the assumed exchange rate is likely to be just as much, if not more, relevant.

Last year, wherever we visited mining operations, throughout Africa, (naturally Europe), and China, the currency wanted was Euros, not US$. The US$ is no longer the No.1 international currency, in China it appears to have sunk to No 4 in the space of only 4 years. In China it was in fact Euros, then GB Pounds, then A$ (some hotels that we stayed at didn’t want to accept US$, they wanted and asked for A$), and finally US$. At the markets, in China it was Rmb and in Africa Euros, no one wanted the US$ any more.

Has it spread to South America yet, we will have to see when we go there in about a week or so (end February 2008).

The writing was on the wall when the Euro was introduced, but few people were reading it, basically the grey or black market (there are many rumours as to its actual size) switched from using US$ to using Euros. No longer was it necessary to convert from a European currency into US$ and then back into another European currency, it could simply all be transacted in Euros.

With the difference in interest rates between different countries theoretically influencing the exchange rate, and the interest rates in the US currently plummeting relative to other countries, theoretically (ERA’s view) the US$ should weaken. Admittedly the whole argument is not simply a question of interest rates, however, the American Empire appears to be waning (whether because its reached that time or due to the excesses of non-existent/financially created money) and the Chinese Empire appears to be re-emerging. Now if China decides to no longer back the US$...

Gold Price

When we used to model the gold price, we used the Chamber of Mines’ of South Africa’s model (see Goode News in Paydirt, January 2003) which was based on a linear regression of four parameters being the real US long-term interest rate, the Brent oil price, the DMK/US$ exchange rate and the annual increase in USM1 money supply led by 4 quarters (or one year) to provide inflationary expectations, and a “constant” to balance the equation deriving the US$/oz gold price.

Well, real US interest rates are falling very nicely (after deducting the USCPI), oil as we know is strong, the DMK/US$ would now be Euro/US$, and USM1 money supply is soaring (along with inflationary expectations too), so the gold price could easily get to US$1000/oz or US$1100/oz or higher. Just from a comparison basis consider what could be purchased for US$850 (for 1oz of gold) in January 1980 compared to what US$850 can purchase now. Even the platinum price has more than doubled to >US$1800/oz (compared to its spike up to about US$900/oz at about the same time [January 1980]).

Gold is also benefiting from physical demand from wealthier emerging middle classes in China and India, who both have a historic affinity to hold/ invest in gold. Although, it should also be recognized that while gold is a haven of safety in times of market weakness, it is still an asset, and if investors lose on their other assets, their gold holdings get sold to finance the losses on those other assets.

However, for Australian gold companies, the gold price they receive or hence their profit is going to depend on the A$/US$ exchange rate they receive. From an interest rate differential viewpoint, the A$ could easily rise to parity with the US$ or even higher, maybe even 1.10US$ per 1A$. That could keep the A$ gold price in the A$1000/oz vicinity, which is still a decent price on which to make a profit. It should also be recognized under this scenario, that US$/oz costs will rise, and perhaps that is why Newmont recently announced the intention to sell most of its Australian gold mines.

Fortunately Australian gold share prices have historically been based on the US$ gold price, but for how much longer ? The relationship has also become cloudy under the current uncertain times with Australian shares still following the movements in the Dow, and the fact that a number of the shares have been bought in various forms using part of the reputed A$36bn in Australian margin loans.

Base Metal Prices

As for the base metal prices, many analysts/forecasters remain locked into historical benchmark price levels that were achieved, and still appear to expect metal prices to fall back to those levels. Those levels are historical and with demand and a weak US$ appear unlikely to ever be achieved again.

The fact of the matter is that costs are rising, and with a weak US$, will appear to rise even more, pressuring metal prices to remain high for producers to make a profit so as to produce metal to satisfy demand, and that in itself should result in minimum floor price levels.

However, the currency forwards that various companies took out also need checking to see whether the company benefits or loses from them depending on what stance they assumed.

I suppose the next question, is when does the market completely switch away from prices in US$/oz, US$/lb or US$/t, into Euro/oz, Euro/lb and Euro/t ? We can recall serious consideration being given at one time to quoting all the metal prices in GBP (/oz, /lb, /t etc), but the US$ won that time.

Disclosure and Disclaimer: This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, (an independent research company) who is an Authorised Representative with Taylor Collison Ltd, and with his associates, holds interests in some of the stocks mentioned in this article. The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents.